Retail Investors Lack Basic Financial Literacy

“American investors lack basic financial literacy,” according to a new report from the Securities and Exchange Commission (much of which is based on an earlier report by the Congressional Research Service at the Library of Congress). Many fail to grasp compound interest, don’t understand fees and other investment costs, and aren’t aware about the risks of investment fraud.

From the report summary:

According to the Library of Congress Report, studies show consistently that American investors lack basic financial literacy. For example, studies have found that investors do not understand the most elementary financial concepts, such as compound interest and inflation. Studies have also found that many investors do not understand other key financial concepts, such as diversification or the differences between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns. Moreover, based on studies cited in the Library of Congress Report, investors lack critical knowledge about investment fraud. In addition, surveys demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population. The Library of Congress Report concludes that “low levels of investor literacy have serious implications for the ability of broad segments of the population to retire comfortably, particularly in an age dominated by defined-contribution retirement plans.”

The report goes on to discuss ideas for increasing financial literacy and increasing the transparency of fees and other investment costs.

People sometimes talk about financial literacy as though the goal is helping people choose their own investments. That can be helpful, but the report rightly discusses another goal: improving consumers’ ability to work with financial advisors.

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9 Responses

The problem of financial illiteracy is a serious one and yet it gets scant public attention.

The report cited here focuses on financial literacy of “investors” and suggests a study be done to gauge the level of that (il)-literacy with the apparent goal of introducing more federal regulation on disclosures. I think this largely misses the point—I doubt more federal regulation is going to significantly alleviate the problem.

Financial literacy is a problem not only for investors but even more so for consumers. (If one is an “investor” that already signals some financial literacy. Everyone is a consumer, but quite a few consumers are not investors). The lack of knowledge about compound interest, for example, is a greater problem for consumers who don’t understand the cost of credit card debt, mortgage debt and other types of loans. “Investors” generally understand the benefits of saving—otherwise, they would not do it.

Although it is not necessarily a choice between smart regulation and education, emphasis needs to be given to introducing more courses on basic financial topics in secondary and even primary schools. Presumably, education at those levels is intended primarily so that students can achieve independence by earning money; however, almost no attention is given to spending the money earned wisely, saving it or growing it. Students learn how to drive an auto in high school, but they don’t learn how to wisely purchase one.

This post caused me to do a search of what is now happening in our schools to teach financial literacy. The first hit was this one:

There have apparently been some moves at the state level to mandate financial literacy courses. That is the proper level and approach. There are many things taught from K-12 that are much less important and vital to students’ futures than this. Increased financial literacy would have huge beneficial effects for those students, as well as the economy and country as a whole. It would likely increase our savings rate, reduce the dependence on entitlement programs and help prevent debt-fuelled financial crises like the one we are currently going through. It might even save quite a few marriages!

Financial illiteracy is deliberate. So much easier to fleece the ignorant. Basic budgeting isn’t even taught in schools anymore. We use fiat currency backed by nothing but a promise that it will be worth something when we want to use it- money that’s issued by a private corporation – the Federal Reserve – for which they charge every u.s citizen. Which they make legitimate by it being the only legal tender by which to pay taxes.

There is ignorance aplenty few realize the income tax exists largely to feed money to the Federal Reserve which is owned by the largest banks and the families that own the majority of the stocks in those corporations.

There would be riots in the street were most of the citizens to understand their predicament and the great scam that has been setup by their corrupt leaders.

Financial ignorance and bread and circuses are our entire way of life in the United States. Were television to suddenly disappear, were food stamps and welfare to vanish, were an understanding of the real economic system to suddenly become common knowledge, the skies would blaze, the banks would burn and the government would kill its own citizens. Let sleeping dogs lie, the house collapses soon enough, no sense in waking the soon to be dead, They would only open their eyes long enough to see the horror and feel the pain and then pass from this veil of tears.

The problem here is not financial literacy. It is an imbalance between environmental complexity and general knowledge levels. The simple answer is to blame the gap on lack of literacy, but many areas of our society have become highly complex to those who are not cognoscenti… Finance, health care/insurance, computers (keeping any Microsoft product functioning!) to name a few. And they change frequently. For those with limited time, interest and aptitude, general understanding might be a good expectation, but making truly rationale choices might be too high an expectation absent general efforts to simplify presentation from the hodgepodge of confusing, often apparently contradictory claims of insiders who are benefited by consumers who are not fully in the know. We can expect literacy, but there need to be efforts to simplify and standardize presentation to permit reasoned comparisons by those who are not experts.

Does a consumer really need to understand compound interest to be able to answer the question “Would you prefer an investment that may go up or down in value, or one that will go only up (but usually more slowly and perhaps not even as fast as prices are rising)?”